India keeps interest rates steady but tone is hawkish

Raghuram Rajan, governor of the Reserve Bank of India (RBI), held the repo lending rate steady at 8 per cent on Tuesday as the markets expected.

As Rajan said himself, the only surprise was the lack of a surprise. But there was plenty more in the governor’s speech that grabbed our attention.

There was still a hawkish tone in the latest monetary policy statement – despite comments that no rate hikes are on the cards if inflation continues to moderate according to the RBI’s plans.

India’s benchmark Sensex equities index was down 0.2 per cent to 22,350.89 by 11.45am in Mumbai following the announcement, while the rupee was up 0.7 per cent at 59.89 to the US dollar.

The RBI is now aiming to bring CPI inflation to 8 per cent by January 2015 and 6 per cent by January 2016, going by a report published by an independent RBI-appointed committee earlier this year. Economists believe the target of 6 per cent may be quite an ask.

Given that the latest reading for February came in at 8.1 per cent, that first target looks doable. “What is interesting is that despite us being around 8 per cent CPI right now, which is almost a year ahead of the flight path, the RBI has not changed expectations,” Sonal Varma, an economist at Nomura, told Bloomberg TV. “The RBI doesn’t think the path to disinflation will be linear.”

That is essentially what Rajan was saying, when he sounded a warning in Tuesday’s announcement:

There are risks to the central forecast of 8 per cent CPI inflation by January 2015 stemming from a less-than-normal monsoon due to possible el nino effects; uncertainty on the setting of minimum support prices for agricultural commodities and the setting of other administered prices, especially of fuel, fertiliser and electricity; the outlook for fiscal policy; geo-political developments and their impact on international commodity prices.

Weather events are vital to prices and growth in India, where agriculture still makes up a large part of GDP and employment. But as Rajan added later in the Q&A, it is too early to guess whether el nino will hit. And even if it does, who knows how much it will affect production and which crops in particular?

On growth, the RBI governor says that real GDP growth could pick up from below 5 per cent in the current fiscal year to between 5 per cent and 6 per cent in the next fiscal year, as there doesn’t seem to be much of a revival in the industrial and service sector, and the performance of the agricultural sector depends heavily on the coming monsoon rains.

“My own sense of potential growth is somewhat nebulous in the sense that to some extent supply constraints in the economy, for example, will have an effect on what we think is the potential growth,” Rajan said, adding that growth in the Indian economy will depend on looming political action.

Another big move expected from the RBI is the doling out of new banking licences and Rajan hinted that the list is ready to be released “fairly quickly” once we have word from the Election Commission, which is currently deciding whether making this announcement so close to the polls goes against the moral code of conduct.

“We didn’t want the potential licensees to get their approvals under a cloud,” Rajan said on Tuesday, having been ultra-cautious and asked the commission’s view. “The point is that we shouldn’t be giving licences every ten years.”

Related reading:
Second-guessing Rajan – and India’s election, beyondbrics
Rajan and the price-conscious Indian shopper: in sync, beyondbrics
Raghuram ‘Volcker’ Rajan… good luck with that, FT Alphaville